This exercise illustrates the basic NPV comparison of two projects with equal lives.
Wellness Company is trying to choose the best investment project from two alternative projects. The company has $30,000 to invest. The information about two alternatives is given below:
The discount rate of Wellness company is 15%.
Required: Give your recommendation to the company in selecting the best project to invest $30,000. Use net present value (NPV) method for your answer.
Net present value (NPV) of project X:
*Value from present value of annuity of $1 in arrears table.
Net present value (NPV) of project Y:
**Value from present value of $1 table
Project Y’s net present value is $9,240 which is more than project X’s net present value. Project Y is therefore, more desirable.
Alternatively, we can compute the profitability index of both the projects as follows:
Profitability index = Present value of cash inflows/Investment required
- Project X: $35,896/$30,000 = 1.195
- Project Y: $39,240/$30,000 = 1.308
We can see that the profitability index of project Y is higher than project X. Project Y is therefore preferred over project X.